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Portugal Heading for ‘Shock’ Year as Crisis Deepens: Euro Credit

Portuguese Prime Minister Pedro Passos Coelho
Pedro Passos Coelho, Portugal's prime minister. Photographer: Michele Tantussi/Bloomberg

With an economy struggling in a recession, Portuguese Prime Minister Pedro Passos Coelho is fighting to avoid the market mayhem that toppled the Italian government last week.

Coelho, whose Social Democratic Party ousted the Socialist government in June elections, is meeting targets set by the European Union and International Monetary Fund in the 78 billion-euro ($105 billion) bailout program, and he plans to implement next year what he calls the “most difficult” budget in memory. He’s slashing state workers’ salaries and avoiding further one-off income-tax surcharges to fill a financing hole.

The risk premium on Portugal’s 10-year bonds fell in the past week, contrasting with the increases of Italy, Spain and France. Portuguese growth averaged less than 1 percent a year in the past decade to rank among Europe’s weakest economies.

“2012 will be the year of shock,” said Diogo Teixeira, chief executive officer of Optimize Investment Partners, a Lisbon-based firm that manages 45 million euros in assets and holds Portuguese government debt. “Most negative effects of the government’s austerity measures will be felt in 2012, whereas the good effects, in terms of increased productivity, may only be felt in 2013 and beyond.”

Borrowing costs have gained since the rescue funds were requested on April 6. The difference in yield that investors demand to hold 10-year Portuguese bonds instead of German bunds reached a euro-era record of 10.7991 percentage points on July 12 and was at 9.44 today, up from 5.11 when former Prime Minister Jose Socrates sought the bailout. The gap was 6.70 percent on June 6, the day after Passos Coelho defeated Socrates to take power.

Italian Gap

The spread stabilized during the past month even as investor concerns about Italy opened a new front in the debt crisis that began in Greece in 2009. The premium on Portugal’s debt narrowed 33 basis points in the past 30 days, while Italian debt widened 118 basis points relative to German bunds and the Spanish gap increased 167 basis points.

“A large part of what will happen in 2012 doesn’t depend so much on Portugal but on what will happen in Greece and Italy,” said Teixeira of Optimize. “If the world does not explode in 2012, the Portuguese situation will solve itself in the best possible way.”

Bill Sales

Italian 10-year bond yields climbed to a euro-era record of 7.48 percent on Nov. 9, passing the 7-percent level that led Greece, Ireland and Portugal to seek international bailouts. Portugal’s 10-year bond yield was at 11.30 percent today and the five-year bond yield was at 13.45 percent. The spread means there is more perceived risk in lending to Portugal for five years than for a decade.

Portugal has no bond redemptions until June when it faces a 10 billion-euro maturity. It sold 1.12 billion euros of bills on Nov. 16, with six-month bills auctioned at an average yield of 5.25 percent and three-month bills at an average yield of 4.895 percent. Portugal aims to return to bond markets in 2013.

Finance Minister Vitor Gaspar said Nov. 16 that the second quarterly review of the country’s financial-aid program was “successful,” allowing it to receive another rescue payment of 8 billion euros. The so-called troika of the European Commission, European Central Bank and International Monetary Fund said Portugal’s plan is “off to a good start” and the 2012 budget includes “bold and welcome measures.”

Passos Coelho said Nov. 10 that Portugal won’t seek a second international financial rescue. “Portugal isn’t asking for more money and isn’t asking for more time,” he said. European leaders have approved a second rescue plan for Greece.

Juncker’s View

Luxembourg Prime Minister Jean-Claude Juncker, who heads the group of euro-region finance ministers, said Nov. 9 that Portugal doesn’t need additional funds. Any adjustment that may take place won’t affect the volume or amount of the country’s aid program, Juncker said.

With the austerity measures, Portugal’s government aims to trim the budget deficit to 5.9 percent of gross domestic product in 2011 from 9.8 percent in 2010, and to the EU ceiling of 3 percent in 2013. Debt will reach 100.8 percent of GDP this year and peak at 106.8 percent in 2013 before starting to decline, the government estimated on Aug. 31. Debt was 93.3 percent of GDP in 2010.

Portugal has to do more than initially planned to meet its budget goals, Passos Coelho said Oct. 13. The government has announced a one-time Christmas income-tax surcharge on all taxpayers to help cover the budget shortfall this year.

Christmas Pay

The 2012 budget includes a plan to eliminate the summer and Christmas salary payments for state workers earning more than 1,000 euros a month. As mentioned in the financial aid program, tax deductions will be reduced and the government plans to increase the value-added tax rate of some goods.

Portugal’s economy will shrink 3 percent next year and then may expand by 1.1 percent in 2013, the European Commission forecast on Nov. 10. It would be one of only two countries with declines in GDP in 2012, the other being Greece with a 2.8 percent drop, the commission said, while the euro area expands 0.5 percent. By contrast, Ireland’s economy will expand 1.1 percent this year and in 2012, according to the commission.

The government may not have much room to extract further income tax increases to meet next year’s deficit targets. Portugal’s GDP per capita of about 16,200 euros is less than half of Ireland’s and about 20 percent lower than the Greek figure, making it western Europe’s poorest country, according to EU data. Greece’s average annual gross earnings were almost twice the Portuguese figure in 2009, and Ireland’s monthly minimum wage is almost triple that of Portugal, the EU data show.

Political Stresses

ECB Governing Council Member and Bank of Portugal Governor Carlos Costa said Sept. 14 that the Portuguese economy can’t continue to have the current level of taxation.

“It’s the decisive year,” said Goncalo Pascoal, head of economic research at Banco Comercial Portugues SA in Lisbon, referring to 2012. “It will be a very difficult year from the economic point of view. It will be a more difficult year from the political point of view.”

Portugal has so far avoided the street riots that have occurred in Athens. Portugal’s biggest labor unions, CGTP and UGT, have scheduled a general strike for Nov. 24 to protest against the government’s austerity measures.

“The 2012 budget will be the most difficult budget to execute that we can remember in Portugal,” Passos Coelho said on Oct. 10.

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